ANALYSIS: I don’t pay much attention to housing affordability measures in New Zealand. That is not to say they are of no use because they do illustrate how expensive houses have become. But when it comes to picking house price growth, they are lacking.
For instance, if a measure shows that housing is over-valued by 10%, that does not mean prices are about to fall 10%. Prices might only be 10% above someone’s measure of fair value because they are on their way to being 20% above this measure or 50%. The same goes for under-valued assets.
These gauges are useful for comparisons within NZ across time and comparisons with other countries at a point in time. They are also helpful when it comes to thinking about risk.
For example, if house prices look well over-stretched and mortgage rates are climbing, then I’ll be inclined to warn about the potential for prices to fall. Conversely, if prices look cheap by recent standards and mortgage rates are falling, I’ll be inclined to say prices look as if they will rise.
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So, where do we sit currently? Interest rates have already fallen almost one percentage point from their peaks if we focus on the ever-popular one-year fixed rate. Given the weak state of the New Zealand economy, it seems reasonable to expect at least another percentage point decline, possibly two. That means a one-year fixed mortgage rate eventually near 4.5%.
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What about some measures of housing affordability? One very simple measure based on running a trend through average nationwide house price levels since 1992 suggested prices were 26% above trend late in 2021. Now they look to be about 12% below this trend. This suggests a natural upward bias to prices as mortgage rates fall but it doesn’t tell us how quickly the market will respond.
Another measure could be the ratio of house prices to incomes. One measure we can construct from Statistics NZ data sits at a 7.2 times ratio from 8.8 early in 2022. This is above the 6.7 ratio just before the pandemic and suggests the speed of price gains this cycle will be constrained. That is probably where my view sits.
Independent economist Tony Alexander: "Peaks take some time to build." Photo / Fiona Goodall
Prices will soon start rising again on average because of falling interest rates. But the extent of gains will be constrained by the following:
- The growing net loss of Kiwis offshore;
- The slowdown in rental growth as foreign workers depart;
- Higher costs for investors;
- Investors looking to cash up to fund what will be a more costly retirement;
- Changes in housing rules allowing more densification and making more development land available; and
- A relatively high level of housing construction this cycle compared with past ones.
On the last point, after the 1997/98 Asian Financial Crisis the annual number of consents issued for new dwellings to be built fell from 26,000 to 20,000. The change associated with the 2008-09 Global Financial Crisis was from 27,000 to a multi-decade low of 13,000.
This time around the fall has been from 51,000 to 34,000 so far, with a low somewhere between 25,000 and 30,000 looking likely.
The shortage factor in play at the same time as interest rates fall away this cycle is much less strong than in the previous two cycles. This implies less than usual scope for house prices to soar and again leaves me favouring a scenario of good times peaking with annual growth between 10% and 15% rather than the 24% early in 2004, 18% in 2016, and ridiculous 31% in 2021.
Excluding the pandemic phase, note how long it took for peak house price inflation to be reached after the 1997/98 and 2008/09 downturns. Peaks take some time to build.
- Tony Alexander is an independent economics commentator. Additional commentary from him can be found at www.tonyalexander.nz
